Go Tell it to the Spartans: Drop Dead

The year was 1975. New York City was in financial trouble. It had to borrow to pay its operating expenses. And lenders were getting tough. So Mayor Abe Beame turned to Washington, begging for a bailout. But America still had a vestigial sense of financial integrity back then. The Big Apple was lucky; America’s president told Beame to “drop dead.” With no other option available, New York’s politicians had to do the right thing – they cut expenses and the city flourished.

Greece is not New York City. And the US is not Europe. America is united from sea to shining sea – at least it has been ever since Lincoln crushed the Confederacy in 1865. A united Europe, on the other hand, has always been cyclical and tentative. Togetherness was usually imposed by conquest. The Romans…the Holy Roman Empire…Napoleon…Hitler… All held it together, but only for a while.

Last week, Europe’s stock was selling off. The euro sank to $1.36 – an 8-month low against the dollar. Short interest against the euro rose to a record high – with $8 billion betting that the European money would go down more.

The immediate problem was in Europe’s soft underbelly. The Greeks are in a jam – similar to New York’s problem in the ’70s. The Hellenic deficit has risen to 12.7% of GDP, sending the cost of funding to nearly 7% for a 10-year loan. As the cost of money rose, so did Greece’s troubles. Each additional basis point of borrowing cost pushed the budget further out of balance.

Greek finance minister Papaconstantinou promised spending cuts that would reduce the deficit down to the allowable 3% level within 2 years. But could he deliver?

During the late 19th century, William Jennings Bryan was the champion of the agrarian debtor class in what is now known as America’s ‘flyover states.’ The Midwestern farmers had gone deeply into debt during the boom years. They wanted more money in circulation to make it easier for them to pay their debts. Bryan whined for bi-metallism…using silver as well as gold as a monetary reserve, thus increasing the supply of money. In one of the greatest speeches of all time, he thundered that debtors were being “crucified on a cross of gold.” America told him to drop dead.

But today’s money is backed by neither silver nor gold. No one will be crucified by paper money; instead, as the bailouts mount up, they will be buried under it. The quantity of government-issued paper is exploding. Public debt in the developed countries rose 50% in the last three years. This year alone, Europe is scheduled to borrow $2.2 trillion more.

Of the leading brands of paper money, America’s is the most reliable. It has been around for two centuries. And it enjoys the full faith and credit of the United States of America. The euro, on the hand, is a recent innovation. It is paper money backed by more paper – the Treaty of Lisbon, from which member states may withdraw when they feel like it. This has led many observers to think Europe’s money is inherently weak and unnatural. Nor does the euro enjoy the kind of dynamic, can-do management that the dollar gets. You can imagine Ben Bernanke turning up at the office at 7AM. Jean-Claude Trichet probably arrives at 11 and leaves after lunch. But which is worse – a currency that is controlled by people who are only marginally interested in keeping it up or one that is backed by people fully determined to make it go down?

Last week, the aforementioned Mr. Trichet seemed hardly inclined to bail out the Greeks. Instead, he lectured them…

“…belonging to the euro area, you…have an easy means of financing your current account deficit. You share a currency that is credible, so that you have a quality of financing that corresponds to that of a credible currency.”

He let it be known that the European Union could do just fine without them. Greece’s GDP represents only 3% of the Eurozone (about the same as New York City’s portion of US GDP). It is 3% the rest of Europe could live comfortably without, he seemed to say.

But by Tuesday, there was hope that Mr. Trichet’s heart may have softened. Or maybe it was his head. He was flying back from Australia early. German lawmakers were being told that they had ‘more flexibility’ to deal with the crisis than they had previously thought. After vague assurances on Thursday, investors were betting that a bailout deal would be forthcoming.